This is part 12 of our series discussing the sale of a business from the seller’s perspective. Previously, we covered the commencement of a potential deal through the closing and post-closing indemnification terms. In this post, I will discuss some of the key ancillary agreements that are part of most transactions. Specifically, I’ll discuss noncompetition agreements and employment/consulting agreements and provide some tips to sellers when negotiating these documents.

Noncompetition agreements are a standard part of most sale of business transactions. No buyer is going to pay for a business and have the seller turn around and start competing with the buyer in the near future. Therefore, the sellers should generally expect to sign noncompetition agreements.

The same is often true with employment/consulting agreements. Many buyers will want and need key seller parties to stay on after closing to help retain key customer and other relationships and generally to help the business transition smoothly. Therefore, sellers should expect to sign a consulting or employment agreement.

With both documents, there are several key provisions that should be considered and negotiated from the seller’s standpoint. Here are some key decision points and tips for handling some of them.

Restrictive Covenants — these covenants will likely be included in both the noncompetition agreement and the employment/consulting agreement. These covenants will prohibit the sellers from engaging in various activities, including competing with the business purchased by the buyer, soliciting customers of the buyer, and soliciting employees of the buyer. The noncompetition and nonsolicitation provisions are often particularly important as many buyers may want to pursue other business ventures at some point. Here is a list of key items to consider and negotiate:

Restricted Activities – The sellers will want to make sure the restricted activity is not overly broad; the definition should be narrowly tailored to protect the buyer and the business it is purchasing but not prohibit other activities. Often, after selling a business, the sellers find another business opportunity that involves relationships that were created while they were running the original business that was sold, and the sellers will want to make sure they can take advantage of such an opportunity.

With respect to soliciting existing customers or suppliers of the business, consider whether the seller is prohibited from soliciting these persons for business that competes with the business purchased by the buyer or for any business. If the seller does decide to start a non-competing business after closing, it may want to use its existing relationships, and this should be agreeable to the buyer so long as it’s not a competing business.

Restricted Period – The buyer obviously wants the period during which the sellers are restricted from competing with the purchased business to be as long as possible, whereas the sellers want it to be as short as possible. I most often see five-year restrictions in the covenants contained in the noncompetition agreement and two years in the employment agreement[1] (that is, the restricted period lasts for the term of employment and for two years thereafter); however, the sellers will want to consider the terms carefully in the context of any future plans and determine what must be given to satisfy the buyer but nothing more.

Breaches by Buyer – What if the buyer delivers the seller a promissory note for a significant portion of the purchase price and then defaults on the note? Should the restricted covenants lapse? The buyer may vigorously resist a provision terminating the restrictive covenants in this case but it’s certainly reasonable to ask to include such a provision. It gives the buyer more incentive to follow through with its obligations.

Employment-related Terms – The sellers signing employment or consulting agreements will want to consider many items. Those such as salary and benefits are obvious, but many other provisions should be considered too.

Time Commitment — Will the sellers work full-time or part-time? Will they be required to be in the office during regular business hours?

Title and Position — What title and position will the sellers hold? And who will the sellers report to? Often, these can be important points, particularly if there are earn-outs on the table (discussed previously in this post), in which case, the sellers may want to have significant control over the operations for some period after closing to maximize the earn-out potential.

Term of Agreement; Severance – What is the term of the agreement? Can the agreement be terminated earlier by either party? If the seller’s employment is terminated prior the end of the term and the termination is not for “cause” or is by the seller for “good reason”, will there be a severance payment to the seller?

Outside Activities — Are there restrictions on outside activities other than competing business ventures (e.g., many sellers may have a side business or venture or be involved in community or charitable activities that should be permitted after closing).

Death or Disability – What if the seller dies or becomes disabled?

This is only a partial list of important points to consider and each deal is unique. However, it should be obvious that there are many important provisions to consider with respect to the noncompetition and employment-related agreements.

In the next post, we’ll wrap up our discussion of the sale of a business from the seller’s perspective.

Footnotes

[1] Applicable state law needs to be investigated to determine what is enforceable in terms of restrictive covenant time periods and other matters.

Casey Riggs is a corporate and business attorney who represents companies of all sizes, from startups to large corporations, and in all stages of the business life cycle, from entity formation through an exit event. Casey also represents many of his clients in estate planning and administration.

Comments

Thanks for a useful piece of information. Do you have any information on California region business laws that one should keep in mind while engaging with a party based outside US for any kind of selling or buying.